Mellody's Math: Tax Day Arrives
April 15, 2005 — -- Today is tax day and millions of American still haven't filed. In fact, of the 133 million people paying taxes this year, the IRS estimates 25 percent will wait until the last two weeks to file -- about 33 million Americans. Despite the deadline, believe it or not, you still have time to stay in good graces with the IRS.
No matter what your situation, you do not want to ignore the deadline. Failing to file can dramatically increase fines and penalties -- potentially by almost 50 percent of your original tax bill. This can result from interest, failure to file and late fees. The last thing you want to do is not pay and pretend your tax bill will go away. Not paying your income taxes is a criminal offense and, in severe cases, people can be charged with both criminal and civil penalties. The IRS may take several unpleasant actions to secure payments when taxpayers do not pay voluntarily. For example, the IRS has the power to place a lien against your property until your outstanding tax bill, plus interest, is paid in full.
If you know you can't get all of your paperwork together, simply file for an extension -- Form 4868. The form takes only minutes to complete and automatically gives you an extra four months to file your return. Keep in mind, an extension only buys you extra time to file -- not additional time to pay your tax bill. Certainly, your best option is to pay in full. However, if you file a return or an extension by April 15, you at least avoid the government's failure to file fee -- usually 5 percent each month, up to a maximum of 25 percent of your unpaid tax bill.
The IRS requires you to make a good-faith estimate of your tax bill. If your payment accounts for at least 90 percent of your total tax due you will not be assessed a late-penalty fee. However, you will still need to pay interest on the amount of the tax that was not paid. The easiest way to estimate what you owe is to look at your return from 2003 to see what you paid the IRS last year.
Tax penalties are steep, so if you can't pay everything -- pay what you can. The interest on your unpaid balance compounds daily and you will also be slapped with a monthly late payment penalty by the IRS. If you can pay off your bill sooner rather than later, you minimize additional charges and avoid digging yourself into an even bigger financial hole.
To pay off your tax liability within the next 24 hours you can secure a loan or arrange a payment plan with the IRS or pay by credit card. Let's look at your choices:
One area where you could get a quick loan to cover your tax bill is at the financial institution where you currently have an account. This type of loan is called a secured loan. Do not get tempted with offers from financial institutions that offer unsecured loans as the interest rate will likely far exceed that of a secured loan. These types of loans are often referred to as predatory lending.
The government offers three payment agreements:
1) A direct debit plan that electronically withdraws funds from your bank account or other financial institution such as a mutual fund or credit union. It is important you double check to make sure your financial institution will agree to this.
2) A payroll deduction plan automatically deducts money from your paycheck each month.
3) The third option is a routine installment agreement -- in which you are billed a specified amount each month.
The first two options are automatic payment plans and can be helpful in minimizing missed payments. For each government plan, there is a one-time set-up fee of $43. On top of that, you are responsible for interest plus the monthly late penalty. The government adds an additional 3 percent to the going federal short-term interest rate -- which means you are paying a lot. The late penalty is a separate fee, typically less than 1 percent per month, higher if you don't file a return.
One option that you should avoid at all cost is paying your taxes with a credit card. When you pay with plastic, you will likely incur a 2.5 percent convenience fee and the possibility of an interest payment greater than your taxes due. Take a look at the math:
If you owe $3,000 to the IRS and opt to pay with a credit card, you will automatically be assessed an additional $75. In addition, if you pay only the minimum on this charge, assuming an 18 percent APR and no additional charges to your credit card, it would take you more than 22 years and cost an additional $4,100 in interest to pay off this balance!
There is special assistance to those in very unique circumstances either because an individual is facing severe financial hardship -- sometimes because the actual tax liability is in question.
You may be eligible for an Offer in Compromise. In this rare situation, the IRS may be willing to settle, minimize or waive tax liability. Know that the IRS resolves less than 1 percent of accounts through this program. To be considered, all previous tax returns must have been filed. Additionally, there is also a $150 application fee, which may be waived due to severe economic hardship.
Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is "Good Morning America's" personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.